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MARKET > Commentary Sunday, April 29, 2001
by: S.P. Brown
Editor

No More Chicken Little

Maybe things really are not that bad after all, at least if you trust last week's slate of economic data sets. On Wednesday, a couple of reports were released that proved the housing market is as strong as ever. Then on Friday, another report was released that proved the rest of the economy isn't doing too badly either.

According to the Bureau of Economic Analysis, Gross Domestic Product (GDP) for the first quarter of 2001 rose 2.0 percent, which was double the 1.0 percent estimate forwarded by those erudite types who eke out a living forecasting such things. What's more, consumer spending, which accounts for two-thirds of GDP, remained healthy in the quarter, rising 3.1 percent after rising 2.8 percent in the fourth quarter of 2000.

On the business end, the news was equally as bullish. Business investment also exceeded expectations, rising 1.1 percent for the first quarter after declining 0.1 percent in the fourth. More importantly, the inventory correction appears to be further along than previously believed. Inventories dropped by $7.1 billion after rising $55.7 billion in the fourth quarter of 2000. The drop in inventories was the first in 10 years and the largest since the third quarter of 1991, which is when the bull market kicked into gear.

All in all, these reports were taken as an indication that the economy has indeed bottomed. Arguably, the data support the view that the Fed's rate cuts are working and that growth will improve in the second half of the year.

Of course, there is a dark side to a recovering economy and that's a possible reduction in interest rate cuts. The strength of these reports has some market watchers lowering their expectations for the size of the Fed's next rate cut, which currently is expected to be 50 basis points, though many market participants are beginning to think 25 basis points may be in order.

Despite the strong economic reports, consumer optimism remains tepid. According to the University of Michigan's final index, consumer sentiment fell to 88.4 in April from 91.5 in March. Since November, the index has fallen 19.2 points, the biggest drop since July to October 1990. The resent rash of corporate layoffs must be taking a toll on consumer psyche.

Fortunately, though, these layoffs are not taking a toll on trader psyche, particularly traders who ply their trade in those New Economy issues that were thought immune to such pedestrian business issues as layoff. Once again, the Nasdaq Composite Index (COMPX) was the percentage leader on Friday. The index closed the day up 40.82 points, or 2.01 percent, to 2,075.70.

Much of these gains came courtesy of its chip issues. Intel (Nasdaq:INTC) gained $1.54 to $30.18 after reiterating its recent outlook on capital spending and industry growth for the year. The company also said that communications growth will return in the next six to 12 months.

Moving in tandem with Intel were those companies that supply the chip making giant with the gear necessary to make its products. Altera (Nasdaq:ALTR), KLA-Tencor (Nasdaq:KLAC) and Applied Materials (Nasdaq:AMAT). Taken together, these issues helped lift the PHLX Semiconductor Index over 5 percent on Friday.

As for the Old Economy barometer, it also put in a decent showing. The Dow Jones Industrial Average (INDU) gained 117.70 points, or 1.10 percent, to 10,810.05. Of the 30 INDU stocks, 24 posted gains. Alcoa (NYSE:AA) and Caterpillar (NYSE:CAT), both cyclicals, reached fresh 52-week highs.

In the broader market, the S&P 500 Index (SPX) added 18.53 points, or 1.50 percent, to finish at 1,253.05. This oft-quoted arbiter of bull and bear markets is trading at a 17.9 percent discount to its March 2000 closing high of 1,527. Three weeks ago it was trading at a 27.8 percent discount.

Speaking of the SPX, there are five companies in the index set to be acquired by midyear: Honeywell (NYSE:HON), Quaker Oats (NYSE:OAT), Harcourt General (NYSE:H), GPU (NYSE:GPU) and Willamette Industres (NYSE:WLL). According to Barron's, Salomon Brothers figures the likeliest replacements are Juniper Networks (Nasdaq:JNPR), Bea Systems (Nasdaq:BEAS), eBay (Nasdaq:EBAY), United Parcel Service (NYSE:UPS), John Hancock (NYSE:JHF) and Genzyme (Nasdaq:GENZ).

If the market believes Salomon's assessment is correct, there is a good chance these stocks will have strong underlying support for the next couple of months. Moreover, of these six SPX candidates, I think UPS is the most intriguing because it's also a candidate to replace Honeywell on the INDU.

In Splittrader stock news, our Current Play list put in another stout performance last week. We posted a 7 percent gain in Jacobs Engineering (NYSE:JEC) and a 6 percent gain in SouthTrust Corp.

Our big winner, though, was lottery systems provider GTECH Holdings (NYSE:GTK), which finished up over 8 percent for the week. On Friday, the company announced that Louisiana Lottery extended it contract with GTECH for another five years. GTECH estimates revenues will be approximately $40 million over the five-year contract extension period.

We did have one notable loser, Union Pacific (NYSE:UNP), which hit us with a 7 percent loss. We were expecting the stock to run into its earnings report on Thursday, which it did, but not before touching our stop loss at $54.50.

In the Treasury arena, bond prices fell Friday, sending yields up, as traders bet the good ole days of free-falling interest rates are just about over. The 10-year Treasury note yield surged to 5.32 percent compared with 5.17 percent late Thursday. The 30-year bond's yield leapt to 5.80 percent vs. 5.70 percent. The good news is the yield spread between the 2-year note and 30- year bond swelled to 174 basis points, the widest it's been in nearly seven years.

On the economic front, there wasn't much worth noting on Friday aside from the GDP report. As for the coming week, personal income and consumption spending for March kick things off on Monday. Personal incomes are expected to have increased 0.5 percent, up from a 0.4 percent increase in February. Personal spending is expected to have risen 0.2 percent in March, off from a 0.3 percent gain in the previous month.

On Tuesday, construction spending, and the National Association of Purchasing Management's (NAPM) index of manufacturing activity will be released. Construction spending is forecasted to have increased 0.3 percent in March, off from 0.6 percent gain the prior month. The NAPM index is expected to post at 43.6 for April, up from 43.1 in March. A NAPM index reading of below 50 indicates contracting business conditions within the sector.

The week's most awaited economic data sets will be released on Friday. The unemployment rate, average hourly earnings, change in non-farm payrolls, change in manufacturing payrolls, and average weekly hours are due. The unemployment rate is expected to rise to 4.4 percent for April, up from 4.3 percent in March, average hourly earnings are expected to have increased 0.3 percent in April, off from March's 0.4 percent gain. The economy is forecasted to have added 20,000 non-farm jobs in April compared to a 86,000 non-farm jobs in March. Average weekly hours are expected to post little changed at 34.2 in April, from 34.3 in March.

As for earnings, this week marks the end of the busiest period for corporations posting first-quarter results. Notables reporting include Hewlett-Packard (NYSE:HWP), Proctor & Gamble (NYSE:PG), Loews (NYSE:LTR), Tricon Global (NYSE:YUM), Priceline.com (Nasdaq:PCLN), and Royal Dutch Petroleum (NYSE:RD).

About four-fifths of the companies in the S&P 500 have issued earnings so far and profits have fallen 5.2 percent from a year ago, according to First Call. The drop in earnings is projected to hit 7 percent for the S&P 500, compared to strong growth of 23.6 percent a year ago. While many companies have beaten lowered forecasts, the first quarter is expected to be the worst quarter for profits in a decade.

With earnings concerns still weighing on traders' minds, I think the upside in both major market barometers will again be limited this week. Last Sunday I said the market would likely be flat for the week. I was close; the INDU finished up 2 percent while the COMPX finished down 4 percent.

This week I again expect little movement one way or the other, particularly on the COMPX, which is in a near-term trading range between 1950-2,200. Based on Friday's close of 2,075, we are smack-dab in the middle of this range, so I think the risk/reward scenario on the COMPX is a wash.

With that said, I think that the COMPX may have a chance to challenge 2,200 later in the week if it can hold its 50-dma at 2,020 through the first few sessions. It's also important to note that the 10-dma, currently at 2,050, also provided the COMPX with some support last week. However, I don't think this level is nearly as important as the 50-dma, which is contrary to what some technicians have been saying.

As for the INDU, it's fast approaching 10,864, which marked the beginning of the March free-fall, so I think that the average could meet some resistance at that level. Still, I wouldn't discount the INDU's ability to blow through this level. After all, it handled resistance at 10,700 with relative ease.

The key for the INDU will be its ability to hold its steep April trendline. If it can do that, I think it has a shot at 11,000. However, given that the INDU has run nearly 15 percent this month, I think that's going to be difficult to do. So with potential upside of 200 points and potential downside of 400 points, I think the risk definitely outweighs the reward at this point.

Should we get a decent rally early in the week, I doubt that it will be long-lived, so keep those stops tight to lock in your profits. As a guide, keep stops no more than 10 percent below the stock current price and look for natural levels of support like moving averages (the 10-dma is often a natural support level) and most recent consolidation ranges.

S.P. Brown
Editor
www.Splittrader.com

 


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